January 27, 2007

Tax Free IRA Rollovers as Short-Term Loans: Two Examples of What Not to Do

Houston Tax Attorney Blog

Houston Tax Attorney

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Taxpayers often withdraw funds from their IRAs to cover short-term expenses with the hope that they can put the funds back in their IRA within the 60 day window for making a tax-free IRA rollover. When taxpayers miss this 60 day window, they are forced to ask the IRS to waive the 60 day time period based on “equity” and “good conscious.” The IRS just released two new private letter rulings based on “equity” and “good conscious.”

The IRS did waive the 60 day period in Private Letter Ruling 200704040. According to this letter ruling, the taxpayer withdrew monies from his or her IRA retirement account in order to purchase a home. The credit union that held the IRA told the taxpayer, incorrectly, that the funds must be deposited in another IRA on the date that was 62 days from the date of withdrawal. The credit union admitted that its employees miscalculated the 60 day period and the credit union, upon consultation with their tax attorneys, paid the fees associated with making the IRS private letter ruling request. The IRS held that the taxpayer’s reliance upon the date provided by the credit union was sufficient to waive the 60 day requirement.

Compare that to Private Letter Ruling 200704042. In this letter ruling the IRS refused to waive the 60 day period for rolling funds over to a new IRA. The facts for this ruling were that the taxpayer suffered a mental impairment. The taxpayer’s representative (probably a family member who was acting pursuant to a power of attorney document prepared by the taxpayer), withdrew the taxpayer’s IRA funds to pay for the taxpayer’s medical bills – not realizing the tax consequences of withdrawing money from the IRA. Upon consultation with a tax attorney, the representative submitted a ruling request to ask the IRS to waive the 60 day requirement. The IRS held that the taxpayer’s representative’s lack of knowledge about our tax laws was not sufficient to waive the 60 day requirement.

Reading these two rulings together provides an example of the difficult decisions that IRS employees often have to make and the level of discretion that IRS employees have in making these decisions. These two rulings also show taxpayers what not to do if they are considering withdrawing funds from their IRAs for temporary periods.

Obviously, taxpayers should try to meet the 60 day deadline for repatriating their IRA funds. If the taxpayer is worried that this deadline might be missed, then the taxpayer should have a practice of only working with less than competent, but 100% honest, tax and other financial advisors. Taxpayers should not rely on family members or friends, even if those persons are also tax attorneys.

Is this the lesson that the IRS wants taxpayers to learn?

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